China called for the creation of a new currency to eventually replace the dollar as the world’s standard, proposing a sweeping overhaul of global finance that reflects developing nations’ growing unhappiness with the U.S. role in the world economy.

The unusual proposal, made by central bank governor Zhou Xiaochuan in an essay released Monday in Beijing, is part of China’s increasingly assertive approach to shaping the global response to the financial crisis.

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Mr. Zhou isn’t the first to make that argument. “The dollar reserve system is part of the problem,” Joseph Stiglitz, the Columbia University economist, said in a speech in Shanghai last week, because it meant so much of the world’s cash was funneled into the U.S. “We need a global reserve system,” he said in the speech.

Dr. Krugman says China is stuck with dollars and now is looking for easy way out.

The big news last week was a speech by Zhou Xiaochuan, the governor of China’s central bank, calling for a new “super-sovereign reserve currency.”

The paranoid wing of the Republican Party promptly warned of a dastardly plot to make America give up the dollar. But Mr. Zhou’s speech was actually an admission of weakness. In effect, he was saying that China had driven itself into a dollar trap, and that it can neither get itself out nor change the policies that put it in that trap in the first place.

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Two years ago, we lived in a world in which China could save much more than it invested and dispose of the excess savings in America. That world is gone.

Yet the day after his new-reserve-currency speech, Mr. Zhou gave another speech in which he seemed to assert that China’s extremely high savings rate is immutable, a result of Confucianism, which values “anti-extravagance.” Meanwhile, “it is not the right time” for the United States to save more. In other words, let’s go on as we were.

That’s also not going to happen.

The bottom line is that China hasn’t yet faced up to the wrenching changes that will be needed to deal with this global crisis. The same could, of course, be said of the Japanese, the Europeans — and us.
And that failure to face up to new realities is the main reason that, despite some glimmers of good news — the G-20 summit accomplished more than I thought it would — this crisis probably still has years to run.

China’s 2007-2008 bet on global equities and riskier bonds likely cost it north of $50 billion — it all depends on exactly how much of its portfolio it put into risk assets. To be sure, it is in far better shape than Ontario Teacher’s Pension Plan, which lost a staggering 40% on its fixed income portfolio. Most of China’s reserves were in safe government bonds, and those bonds increased in value over the course of the crisis. But as Arvind Subramanian notes, China’s currency losses will eventually dwarf its equity market losses.

Those losses shouldn’t be a surprise. Currency losses on unneeded reserves are the price a country pays for subsidizing its exports with an undervalued exchange rate. But that doesn’t make it any easier to accept the losses – or to handle the inevitable argument that China’s leaders squandered China’s reserves.

China’s leaders are setting the stage to argue that these losses are the fault of bad US policies. They aren’t. They are the result of China’s own policy choices. Subramanian correctly observes “[China] is seeing itself as the victim of the dollar standard when it has been, for a long time, a beneficiary and promoter of this standard.” China’s leaders, though, have no incentive to recognize this.

But even if China didn’t explicitly plan to build up to many reserves, it now has them — and China’s leaders are no doubt interested in using them to increase China’s influence.

It isn’t hard to think of creative ways China could use its reserves to increase its global position. China alone could provide all the extra $500 billion the IMF now needs if it wanted to do so. Or it could set up a Chinese monetary fund to compete with the IMF.

To date, China has been fairly cautious, generally turning down countries that trekked to Beijing to appeal for emergency loans – though the recent expansion of RMB swap lines suggests that China may now be willing to take more risks. One potential problem: China would need to explain to its own citizens why it is using its reserves to help other countries rather than doing more at home.*

And then there is the elephant in the room: Will China’s large dollar holdings — and the fact that is is now the United States largest creditor — give it any influence over US policy?

No matter how this whole situation turns out, what China is going to do with its massive dollar reserves will decide the future of the US, the world financial system and US-China relationship. A lot depends on how China behave from here on.

Shining metals are shining like never before – however old let it be, it is still Gold.

The recent rally in Gold is two thumbs down by owner’s of the wealth to the ponzi scheme fraudsters called central bankers, who print pieces of paper called currency notes and tell you to pretend that it is substitute for your wealth.

For there will be blood and chaos – perhaps all of 2009, perhaps more. And when this ends, a new world order will emerge. But first, we need to weather this storm.

People thought that history will treat George Bush as someone who brought US to her new lows. Now it appears that history will remember Mr. Bush as someone who drilled such big a hole in the titanic of US that it was just a matter of time before it eventually sank.

FRONTLINE released its documentary ‘Inside the Meltdown’ on PBS.org capturing the dramatic wall street events of 2008.

The documentary runs for 1 hour capturing the events starting from Bear Sterns collapse. Devoid of any charts and figures, the focus of documentary is to present timeline, events and anecdotes rather than presenting an analysis of the crisis. It does meet its goal.

“There comes a time in every economic crisis or, more specifically, in every struggle to recover from crisis, when steps up to the podium to promise the policies that – they say – will deliver you back to growth. The person has political support, a strong track record, and every incentive to enter the history books. But one nagging question remains. Can this person, your new economic strategist, really break with the vested elites that got you into this much trouble?”Simon Johnson, professor economics at MIT, former chief economist IMF

Here is the clip of Simon Johnson discussing banking crisis with Bill Moyers.

One of the main culprit of subprime mortgage collapse was principal-agent problem.

For bankers, incentive to cheat and make a quick buck in bonuses was much larger than incentive to earn steady and secure profits for shareholders. There hasn’t been enough discussion surrounding this important area.

Free Markets can work, only if free markets can devise an effective remedy to principal-agent problem. If not, effective regulation is the only alternative.

Bad bank? Hmmm .. bad bank! How good can it be, when they name it bad bank?

What is Bad bank?

‘Bad Bank’ is the new gimmick tossed around by the same people who came up with but could not work out TARP – Troubled Assets Relief Program. The same set of intellientia has rebranded TARP as ‘Bad Bank’ and is running around proselytizing people to their newly formed faith – born again TARP.
“Bad Bank’ aims at isolating toxic trash from banks’ assets and create a new giant bad bank to carry only this toxic junk. This will improve the quality of asset book of all the banks and they will be back in their usual business of lending again. Good thought. So where is the problem?
The problem is, who will provide the capital for ‘Bad Bank’? Since most of the assets that are going to end up on the balance sheet of Bad Bank are worth nothing, they are essentially going to eat up most of the capital. So in the name of which crazy f*ing variant of capitalism, is it fair to ask taxpayers to cough up the capital for ‘Bad Bank’? They call it Lemon Socialism. I am no fan of socialism, but pure socialism is million times better than this Lemon Socialism.
The idea of ‘Bad Bank’ is going to fail for exact same reason the original idea of TARP failed. How to price the Toxic Assets? If they are priced at what they are worth i.e. zero, no bank will be willing to part them from their balance sheets. If they are priced anywhere near their book value, it is really bad deal for taxpayers.

Let’s look at what are the general perspectives we get to hear about Bad Bank.

The smart ones …

These people are the founding fathers of Bad Bank initiatives – the shrewd class of diplomats in cahoots with nation’s bankers. They have their own interests in getting things running again – even if it comes at the cost of taxpayer dollars. They want to sell this idea of Bad Bank somehow, because it is one perfect medicine that will mop up all the dirt from balance sheets of all banks. the ultimate cleansing of body and soul, you see.

The naive ones …

There are always few who fall for such cunning ideas of political craft. They say that toxic assets are in reality worth more than what they sell for in the market. So if gov’t sits over these assets for long duration, taxpayers will end up making profit on in. Okay. So markets don’t know how to price these assets, eh? But wait a minute, markets are supposed to know the best, isn’t it? Yes, and they do. These assets are really worth nothing.

The wise ones …

This includes economists like Joe Stglitz , Paul Krugman and Yves Smith, who openly criticized the idea of Bad Bank in its current form – just because it is exactly what it says it is .. Bad.

Please, oh good Lord, please have some mercy! This is how Mr. Helicopter Ben is praying these days.
Imagine this. Ben is sitting at the Fed window (yes, the same window which he opened for every crook on the street last year) and CEOs of AIG, Big-3, Citi, BofA, WF et al are waiting in the queue for their turn. Everybody takes his turn, gulps down few billions of taxpayers’ money and goes back to stand at the end of the queue waiting for his next turn. The line never ends. Ben is printing money which evaporates at a rate faster than the rate at which any Obama-supporting group fills up on facebook. And where does this money go? Mostly in further writedowns and in executive compensations aka retention bonuses.

Glass is neither half full nor half empty. It is completely empty and broken. No matter how much water you pour in it , glass stays empty .

Bailout and more bailouts

Bailout saga returned last week. Gov’t bailed out BofA in much the same fashion as it did Citi a month back.

Bank of America announced the results hours after it won $20 billion in new capital from the government’s $700 billion Troubled Asset Relief Program (TARP).

Won? I did not understand what CNBC meant by that. So when you lose money and go begging, you win. Nice. Heads I win, tails you lose. Socialize losses, privatize gains. Well played capitalism! I don’t think I am a lefty. But I believe if gov’t must bailout these banks, gov’t should at least punish common-stock holders and management for their sloppy handling.

“It’s one of the first steps toward some positive news and the end of this nightmare,” said Michael Holland, founder of Holland & Co in New York, which manages more than $4 billion of investment

I agree.

On the similar lines, uncle Sam is planning to create big giant state-owned bad bank for everyone to dump their garbage. This is return of TARP. TARP has already used more than half of its allocated money and hardly any of it went to buying troubled assets, which was the original objective of TARP. TARP-phase 1 was more of a Troubled Bank Capitalization Program.

Paul Krugman (here and here), who always argued for capitalization and gov’t equity stake in troubled banks, did not like the new ‘bad bank’ idea a bit. In his compelling argument he says,

I suspect, though I’m not certain, that policymakers are once more coming around to the view that mortgage-backed securities are being systematically underpriced. But do we really know this? And how are we going to ensure that this doesn’t end up being a huge giveaway to financial firms?

I’m not dead set against this proposal — but I’m still waiting for some explanation of why this is supposed to be more than rearranging the deck chairs on the Titanic.

To answer Paul’s question on giveaway, no sir, we are worried at this point if it is a giveaway to banks. The financial markets are in crisis and this is the only way stock market can go up and continue to go further up. We are not worried about taxpayers at the moment, next elections are not due for another four years.

The bad bank plan has climbed the political agenda in the past couple of weeks as the Government has become aware of the extent of the lenders’ bad debts.

Sources said that a bad bank would have to take on about £200 billion of toxic assets. That would take the Government’s total commitment to solving the banking crisis to almost £1 trillion in taxpayers’ money that has either been spent or pledged.

That equates to about £33,000 per taxpayer. The total sum is equivalent to more than two-thirds of Britain’s annual GDP of £1.4 trillion.

The £1 trillion figure includes the £500 billion announced in October to buy shares in the banks and to guarantee their debt. It also includes a further £100 billion fund, which will also be announced next week as part of the rescue package, to provide the banks with cash to lend to ordinary customers and businesses.

As well as creating a bad bank, the Government is planning to use Northern Rock as a “good bank” which can dramatically increase lending to individuals and businesses.

During initial days of TARP, US followed UK’s idea of capitalizing banks instead of buying sh!t. Now UK wants to follow US idea of bad bank. What gives?

Oil Contango

What’s the deal with oil? Why such contango? Are all arbitrageurs dead? Nobody has any money to lend even when clear risk-free opportunity of making a quick buck is staring in the face?

Mark Thoma posted this puzzle on this blog. IMO, the winner is ‘Counter-party risk’.

The entire idea of ‘bad bank’ is also aimed at bringing trust back to the system. Just the problem is how to effect the idea of bad bank making sure that everyone gets the fair deal.

Crisis Watch for the week

In the good news, TED continues to improve. In the bad news VIX and S&P are catching cold. Will TED follow thru?TED spread 1.03
S&P: 850.12 (-4.5%)
VIX: 46.11 (+10.00%)

Ok… so now he is back.
Last week when I sent a mail to Satan inquiring his whereabouts, I got an out of office autoreply saying that he was currently out of office for christmas vacation and will return to haunt the wall street and financial markets in first week of January.

So Dow Jones took a 250 points beating today, but I believe this was just the trailer of what’s more to come. On Friday unemployment numbers and retail sales numbers are due sometime this week. can Obama continue to charm the markets or will the reality check pull the markets down again?

About

08 November 2008
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It’s 08Nov08 today. The financial crisis, which started with housing meltdown in US, has unfolded itself massively on global scale. This diary is an attempt to present the events as and when they happen from now onwards. I will try to keep it as factual as possible and looking to update it at least once in a week.
I am not an economist, so hoping to get layman’s common sense perspective on events of the crisis.
Crisis Diary as it unfolds …